Estimation Of Monetary Policy Preferences In A Forward-Looking Model: A Bayesian Approach

In this paper, the authors adopt a Bayesian approach towards the estimation of the monetary policy preference parameters in a general equilibrium framework. They start from the model presented by Smets and Wouters (2003) for the euro area where, in the original set up, monetary policy behaviour is described by an empirical Taylor rule. They abandon this way of representing monetary policy behaviour and assume, instead, that monetary policy authorities optimize an intertemporal quadratic loss function under commitment. They consider two alternative specifications for the loss function. The first specification includes inflation, output gap and difference in the interest rate as target variables. The second loss function includes an additional wage inflation target.